Ben Bernanke’s speech in Boston on Friday seems to have disappointed those who were expecting him to announce concrete measures to restart quantitative easing, but we already knew from the last set of FOMC minutes that the groundwork for such an announcement had not been undertaken. That announcement will come after the committee’s next meeting on November 2nd and 3rd. Nevertheless, Mr Bernanke has nailed his colours to the mast, even more clearly than he has done in recent speeches. This is a Fed Chairman who is very dissatisfied with the depressed state of the US economy, and who is not afraid to say so.
The important innovation in the Boston speech was that Mr Bernanke went much further than ever before in making explicit the Fed’s objectives for price inflation and unemployment. In the past, there have often been heavy hints about the inflation objective, but now the Fed Chairman has said explicitly that “FOMC participants generally judge the mandate-consistent inflation rate to be about 2 per cent or a bit below”. He then adds that, with underlying inflation currently at about 1 per cent, “inflation is running at rates that are too low” . (His italics, not mine.)
In using this language, the Chairman has pushed the Fed to the very brink of having the formal target for price inflation which he has always seemed to favour. However, it is noticeable that he did not take the further step of discussing the merits of a price level target (analysed in this previous blog). This was left to be recommended in a passionate speech at the same conference by Charles Evans, President of the Chicago Fed, but the Chairman himself has so far steered well clear of the topic.
Mr Bernanke also went further than ever before to define the Fed’s long run sustainable target for the unemployment rate, which he says (uncontroversially) should be “the rate of unemployment that the economy can maintain without generating upward or downward pressure on inflation”. The interesting development is that he goes on to point out that the FOMC’s long run projections for unemployment can be interpreted as their best estimates of the long run sustainable unemployment rate, and that these have a central tendency of about 5 to 5.25 per cent.
The importance of this – and it is very important – is that the Chairman believes that almost none of the recent rise in unemployment has been due to structural causes. Essentially all of the recent rise, in his view, is cyclical unemployment, which can and should be addressed by monetary policy. His summary is simple and stark: “unemployment is clearly too high relative to estimates of its sustainable rate”. (Again, his italics.) So much for those on the FOMC who have been arguing that a large part of the recent rise in unemployment is structural in nature, and therefore beyond the jurisdiction of monetary policy.
This reasoning leads him to conclude that “the short term real interest rate is too high, given the state of the economy”. In other words, “there would appear – all else being equal – to be a case for further action”. However, with short rates already at zero, this action would need to be unconventional in nature, for example involving Fed purchases of longer term securities (ie QE2).
Mr Bernanke ends by saying that the Fed has been proceeding with caution on this, because it has little experience in using asset purchases as a policy instrument, and is concerned about the right way to communicate this policy shift to the public, without causing an undesired increase in inflation expectations. These are sensible concerns, and they are likely to be at the heart of the debate at the FOMC in two weeks’ time.
But given the extent of the Chairman’s dissatisfaction with the state of the economy, and his willingness to express this feeling in increasingly concrete terms, it would be very surprising if the FOMC fails to launch QE2 in November.
